Lecture 6 Disorganized Corruption

1. Anticorruption and the Design of Institutions 2012/13 Lecture 6 Disorganized Corruption Prof. Dr. Johann Graf Lambsdorff

2. Literature • Olken, B. and P. Barron (2009) “The Simple Economics of Extortion: Evidence from Trucking in Aceh,” Journal of Political Economy, Vol. 117 (3): 417-452. • Olson, M. (1993), "Dictatorship, Democracy, and Development," The American Political Science Review, Vol. 87(3): 567-576. • Shleifer, A. and R.W. Vishny (1993), ”Corruption.” Quarterly Journal of Economics, Vol. 108: 599–617.

3. Disorganized Corruption • Businesspeople might sometimes be confronted with many public servants extorting payments. • For example, setting up a new business may require various permits, none of them can be missed. The organization of these multiple payments becomes a daunting task. • Shleiferand Vishny [1993] model this situation: In Russia private investors negotiate with various departments (fire, police, banks ...), each of them requesting a payment in exchange for the speedy approval of a business license. • This leads to the “overgrazing” of the corrupt marketplace.

4. Disorganized Corruption • The problem is comparable to road bandits. • Optimal income for road bandits requires a limit on their activity, so as to avoid that too many travelers are scared off. • Taking, for example, only 20% of the traveler’s money may be best. • But competition among road bandits destroys this calculus: Any money not confiscated will be taken by others. • In this spirit, investors prefer to deal with only one extortionist. Parker and Hart, June 30 1999

5. Disorganized Corruption Assume that there is a total number of n symmetric departments (i, i=1, 2, ..., n) requesting a percentage (bi) of the investment (X). The costs for dealing with this payment, providing the corrupt service and obfuscating are cbi, 0<c<1. Investments (X) decrease with the total amount of bribes, X=X(b1+b2+...+bn), dX/dbi<0. Each department’s profit (Pi) is given by Pi=biX-cbiX. Let us assume that the departments are controlled by a strong party (a monopoly), which maximizes total income of all departments. In this case, they are all forced to behave symmetrically (b1=b2=...=bn), resulting in Pi=(1-c)biX(nbi).

6. Disorganized Corruption • Profit is maximized in the monopoly case if: • After the breakdown of the party the departments start to maximize their income individually, each considering the other departments not to react to their own level of pay-off. Profit maximization is carried out individually by the departments, resulting in: • The second term is no longer multiplied by n. Therefore, a higher bi is needed to satisfy the equation. This is what is known as an “overgrazing” effect. The optimum level of total bribes collected (which was determined in the monopoly case) is missed, because individual bribes are too high.

7. Disorganized Corruption • The propositions of this model have been tested by Olken and Barron (2009). The authors study bribes paid by lorry drivers along two main roads in Aceh, an Indonesian province where separatist guerrillas had long been active. Over nine months in 2005 and 2006, data gatherers accompanied the truckers on 304 trips to and from Aceh, recording more than 6,000 illegal pay-offs at military roadblocks, police checkpoints and weigh stations. During the 637-kilometre (396-mile) trip from Medan to Meulaboh drivers typically passed through 27 checkpoints.

8. Disorganized Corruption

10. In the early stages of each trip, transactions were typically conducted without negotiation—at each stop, drivers simply handed over a few thousand rupiah ($0.50 to $1.00) or a couple of packs of cigarettes. As the trucks neared their destination, however, checkpoint officials demanded increasingly larger sums. At each stop, drivers found themselves with a progressively stronger incentive to avoid hassle and safeguard their cargo, which gave the extortionists greater power over them. • Midway through the study, after the Indonesian government had signed a cease-fire with the rebels, it began a phased withdrawal of 30,000 troops, leading to the number of checkpoints to fall.

12. The amount lost to bribery decreased—but only by 36%. • Fewer stops meant fewer bribes, but this was offset by a rise in the amounts demanded at the remaining checkpoints, whose operators, with entrepreneurial zeal, seized the chance to capture part of the newly liberated surplus. • They behaved like monopolists, setting their prices so as to maximisetheir own revenue, without considering the response of the fellow at the next checkpoint, or whether their activities would deter truckers. • A chain of independent monopolists charges more (in total), but receives less overall than a single monopoly.

13. Disorganized Corruption • Is disorganized corruption better or worse than organized corruption? • This question can be posed more provocative: Should we help extortionists to better organize their illegal business? • Yes: The model predicts that disorganized corruption is worse. • No: Often there exist legal alternatives to the payment of bribes, even for victims of extortion. Disorganized extortion is more costly and induces some actors to prefer the legal alternative. Once corruption is organized, it becomes deeply embedded in a country and widely accepted as the only way for doing business. The model fails in recognizing such legal alternatives such as complaints mechanisms.

14. Disorganized Corruption • This can be illustrated by the following game in extensive form. B requests a bribe to share a joint surplus of 12. E chooses between paying the bribe or complaining and thus resisting the payment, yielding a payoff of 5 (and a positive social externality of 10, denoted by the logo of “doctors without borders”). • Nature then tosses a coin that determines whether the bribe market is organized or disorganized. The latter implies that E and B must share their surplus again with others (the effect of E withdrawing from the market is disregarded here). • Complaining is the dominant strategy.

15. Disorganized Corruption (0; 5) Complain Bribery disorganized (2; 2) N Request Bribe B Pay Bribe E (6; 6) Bribery organized • But if the risk of a disorganized bribery is deleted, paying the bribe is dominant. The “bad” outcome of disorganized bribery can have welfare enhancing repercussions.

16. Appendix Discussions1) Why may a disorganized form of corruption be worse than an organized form, for investors and public servants alike; in how far may independent departments “overgraze the market” when requesting bribes?

17. Exercise:There is a total number of 4 symmetric departments (i, i=1, 2, 3, 4) requesting a percentage (bi) of the investment (X). Costs for providing and obfuscating are cbiwith c=0.5. Investments decrease with the total amount of bribes, a) The departments jointly maximize total income. Determine the resulting investment!b) The departments maximize their income individually, each considering the other departments not to react to their own level of pay-off. Determine the resulting level of investment!c) A powerful kleptocrat may unite the departments, but one type of welfare loss becomes particularly strong and unavoidable. Describe this type of welfare loss!